Why wise investors won’t follow the herd in commodity stocks
Commodities have been strong, but before you invest, say these Canadian small cap experts, look for cash-rich stocks like these three.
Owning stocks has been a good idea for the past year or so.
Especially in Canada. As one group of Canadian experts writes, “with commodities strengthening as the year grew longer, it was better to own them specifically within Canada.”
The Toronto exchange outpaced its New York counterparts thanks largely to the strength of commodities.
So should investors be jumping into commodities with both feet?
Not too hastily, says this same group of experts. These independent researchers publish KeyStone's SmallCap Stock Report in Vancouver, headquarters of many of Canada’s resource companies.
But their stock selections are by no means restricted to commodities. Nor do they believe investors should be rushing headlong into commodity stocks, assuming they will continue to lead the market.
“Many believe they will, but we caution that when too many agree, the opposite tends to occur. We also would be cautious to paint all commodities with one brush.” They will not always rise together.
The message from this advisory is consistent. Do not invest indiscriminately in commodity stocks, or any other hot sector. Concentrate on individual stocks that have the means to get ahead.
Cash-rich producers
These researchers are not disposed to take chances with commodity stocks. For one thing, they must have production now, not just in some rosy future. And they must have money in the bank.
They buy only “cash-rich producers with limited or reasonable debt levels, relatively low cost bases, strong cash flow that can sustain a downturn, and are positioned well to prosper if prices maintain current levels or strengthen.”
This strategy has worked well over the past several years, they report. One of the notable success stories has been Orvana Minerals Corp. (TSX-ORV), a “cash flow generating” gold and copper producer.
It has a producing gold mine in Bolivia and is developing a gold-copper project in Spain and a copper project in Michigan. Trading as a penny stock a year ago, at $0.97, it has risen as high as $3.97. It sits today at $3.31. There is no dividend for this stock, or the other two featured here.
LaMancha Resources (TSX-LMA) operates three gold mines in Africa and Australia and is developing a fourth project in Australia. The shares rose from $1.47 in July to $3.05 in September. They trade today at $2.25 and the stock is cited as a buy in the advisory’s latest issue.
Not least, there are the service firms that stand to benefit from “the extended run in commodities and the multitude of cash built up on the balance sheets of producers and explorers alike.”
The advisory is taking a long look at a past favourite, Wenzel Downhole Tools (TSX-WZL), which makes drilling equipment for oil and gas sites. This stock traded at $1.10 last March, rose to $2.01 earlier this month and now stands at $1.91.
The cold’s still there
Economic growth certainly drives commodities forward, but that growth has to be measured with a cool eye, say these researchers.
A lot of the growth figures for 2010 looked pretty good against the rather tepid figures for 2009. But that doesn’t make them brilliant.
“While the BRIC [Brazil, Russia, India, China] nations are thought to be the new engine for world economic growth, we have also seen the unsustainable effects of two main factors driving the apparent GDP growth over 2010.”
One is government spending, which has given the numbers a “blip” they won’t get again. The other stems from the extensive re-stocking of inventories that has taken place after they were sadly reduced during the credit crisis and subsequent recession.
As corporations fill up their stocks, spending will return to more normal levels. At any rate, adds the advisory, spending is a “problematic” way to measure the success of an economy.
“Economies do not grow by spending, they grow by wealth creation or production.” Spending is an effect of wealth creation, “so we are essentially measuring the effect of wealth creation to quantify growth.”
In short, governments pump in money and pretend that they have “fixed” the economy.
“This type of policy is like suppressing a cough to cure a cold,” says KeyStone's SmallCap Stock Report. “The underlying cold is still there, the symptom has just been suppressed near term.”
The patient doesn’t really get better until the underlying problems are addressed — excessive debt and a lack of wealth creation through production.
That brings the message home to investors. Proceed with caution. And pick solid stocks that are producing and creating wealth.
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